Stiglitz: Turn Left for Growth

Who has the better prescription for economic growth, the left or the right? Joseph Stiglitz says that's an easy call, it's the left:

Turn left for growth, by Joseph Stiglitz, Comment is Free: Both the left and the right say they stand for economic growth. ... There are, indeed, big differences in growth strategies, which make different outcomes highly likely.

The first difference concerns how growth itself is conceived. Growth ... must be sustainable: growth based on environmental degradation, a debt-financed consumption binge, or the exploitation of scarce natural resources, without reinvesting the proceeds, is not sustainable.

Growth also must be inclusive; at least a majority of citizens must benefit. Trickle-down economics does not work... America's recent growth was neither economically sustainable nor inclusive. Most Americans are worse off today than they were seven years ago.

But there need not be a trade-off between inequality and growth. Governments can enhance growth by increasing inclusiveness. ... So it is essential to ensure that everyone can live up to their potential, which requires educational opportunities for all.

A modern economy also requires risk-taking. Individuals are more willing to take risks if there is a good safety net. If not, citizens may demand protection from foreign competition. Social protection is more efficient than protectionism.

Failures to promote social solidarity can have other costs... [For example, the] cost of incarcerating two million Americans – one of the highest per capita rates (pdf) in the world – should be viewed as a subtraction from GDP, yet it is added on.

A second major difference between left and right concerns the role of the state in promoting development. The left understands that the government's role in providing infrastructure and education, developing technology, and even acting as an entrepreneur is vital. ...[examples]

The final difference may seem odd: the left now understands markets... The right, especially in America, does not. The new right, typified by the Bush-Cheney administration, is really old corporatism in a new guise.

These are not libertarians. They believe in a strong state with robust executive powers, but one used in defense of established interests, with little attention to market principles. The list of examples is long, but it includes...

By contrast, the new left is trying to make markets work. Unfettered markets do not operate well on their own... Defenders of markets sometimes admit that they do fail, even disastrously, but they claim that markets are "self-correcting." ...

Markets are not self-correcting in the relevant time frame. No government can sit idly by as a country goes into recession or depression, even when caused by the excessive greed of bankers or misjudgment of risks by security markets and rating agencies. But if governments are going to pay the economy's hospital bills, they must ... make it less likely that hospitalisation will be needed. The right's deregulation mantra was simply wrong, and ... the price tag – in terms of lost output – will be high, perhaps more than $1.5trn in the US alone.

The right often traces its intellectual parentage to Adam Smith, but ... Smith recognised the ... need for strong anti-trust laws.

It is easy to host a party. For the moment, everyone can feel good. Promoting sustainable growth is much harder. Today, in contrast to the right, the left has a coherent agenda, one that offers not only higher growth, but also social justice. For voters, the choice should be easy.

Speculation and Bubbles

Suppose you think that a hurricane might disrupt oil flows in the future. What should you do today? Tropical storm Edouardo gives an example. As the storm approached, people believed there was a chance that oil flows would be disrupted in the future, and the current price began rising as a consequence. If you expect a higher price in the future due to reduced supply or any other reason, you should begin purchasing and storing oil now to take advantage of the higher price in the future, and the increased demand for oil drives today's price up.

This is speculation, the storm may or may not actually hit and disrupt oil supplies, but it's not the kind of speculation we should worry about. We want this kind of speculation - which reflects underlying fundamentals - to occur. The expectation of a supply disruption in the future causes the market to take actions today and store oil for when it will be needed, and this provides insurance against the potential supply disruption, insurance that reflects the probability that the storm will cause problems (the larger the expected fall in future supply, the bigger the price change, and the more that will be stored for the future).

In this particular case, the insurance wasn't needed, but it's still good to have:

''It is pretty much expected the storm is going to slowly weaken now for the rest of the day and overnight,'' said Mike Pigott ... of ... AccuWeather... ''It wasn't anything unusual or spectacular; there wasn't any kind of massive intensification that we saw with Dolly.'' ...

Crude oil touched a three-month low of $118 a barrel on speculation Edouard wouldn't curtail production. Six rigs and 23 platforms were evacuated in advance of the storm, the U.S. Interior Department said yesterday.

Royal Dutch Shell Plc, Europe's largest oil company by market value, said the storm was no longer a threat and it would start regularly scheduled crew changes for its off-shore facilities, according to spokeswoman Darci Sinclair.

Noble Corp., the third-largest U.S. offshore oil driller, may have crews back on two submersible rigs by tomorrow.

The kind of speculation we should worry about is "bandwagon behavior." This is speculation that is disconnected from fundamentals. For example, suppose that people become convinced that offshore drilling will have a large impact on future prices. Even though this isn't true, suppose people become convinced that it is true through some sort of misleading information campaign, perhaps abetted by a media more interested in hyping controversy than in informing people of the facts.

This is the opposite of an expected supply disruption, it's an expected increase in future supply (based upon false information), so the expected future price would be lower. That would cause speculators to release stored oil - it's not as valuable in the future as it was before - driving the price down today, and this validates the markets anticipation that price would fall. Even if you know that the underlying basis for the fall in price is false, if you expect the price to fall further you may jump on the bandwagon and sell stored oil now before the price actually does falls further, and this will amplify the fall in price. To the extent that the fall in price then becomes self-validating, people afraid of a fall in price sell oil which causes the price to fall generating more sales and further price declines, the behavior can feed on itself and generate a large downward fall in prices.

None of this is based upon underlying fundamentals, it's all generated by people buying into the idea that drilling will have a substantial impact on future prices, and changing their behavior because of it. As a political strategy, I suppose it can work if you don't mind misleading people and sacrificing the environment for political gain - prices fall and you can point to the change as evidence that your policy has helped consumers at the gas pump. But eventually the (negative) bubble will pop (hopefully after you are elected), and prices will return where they started.

This type of speculative behavior - bets on price changes that are driven by something other than the underlying fundamentals - is harmful since it distorts both the intertemporal allocation of resources, and the allocation of resources at a point in time. I'm not saying that selling the false claim that drilling for oil will have a large downward impact on prices will create the kind of bubble that makes a bang heard round the world when it pops, or even necessarily affect prices noticeably now or in the future. I think most of the price changes we've seen can be explained by changes in the underlying fundamentals (e.g. see above for an explanation for part of the recent price drop). But the attempt at a distortion is noteworthy in and of itself because if the attempt is successful, it can cause waste and inefficiencies. It shows political gain is more important than telling the truth and solving the problem. Because the fall in price is not based upon fundamentals, it's still a bubble, or perhaps more accurately in this case if I'm wrong and there has been an impact, it's froth (since the price changes we've seen are relatively small compared to the base), and this sends false signals about where resources are needed the most. The people who are doing their best to reinforce the misperception that drilling will significantly impact prices are, to the extent that they are successful, imposing costs on the economy for political gain. This is not the type of speculation we want to see.

This makes another important point. Bubbles do not have to be price increases, they can also occur when price falls (think of a fall in the stock market that is based upon rumors that generate a self-feeding downward cycle that eventually ends, and the price goes back to its fundamental value). We often think of large price falls as the price returning to its fundamental value, and many people are making that claim about oil prices presently, but if there is a negative bubble at work, the fall in price can be taking you away from, not towards, the long-run stable price.

Finally, prices can also be distorted by false information about fundamentals, i.e. an information campaign that misinforms about the relative merits of alternative proposals for dealing with the energy issue. For example, a distortion on the merits of conservation versus drilling could cause us to misallocate resources. Tire gauges and regular tune-ups can do more to help with the energy problem than drilling, but Republicans are doing their best to distort that message and push resources into a suboptimal use:

The Tire-Gauge Solution: No Joke, by Michael Grunwald, Time: How out of touch is Barack Obama? He's so out of touch that he suggested that if all Americans inflated their tires properly and took their cars for regular tune-ups, they could save as much oil as new offshore drilling would produce. Gleeful Republicans have made this their daily talking point; Rush Limbaugh is having a field day; and the Republican National Committee is sending tire gauges labeled "Barack Obama's Energy Plan" to Washington reporters.

But who's really out of touch? The Bush Administration estimates that expanded offshore drilling could increase oil production by 200,000 bbl. per day by 2030. We use about 20 million bbl. per day, so that would meet about 1% of our demand two decades from now. Meanwhile, efficiency experts say that keeping tires inflated can improve gas mileage 3%, and regular maintenance can add another 4%. Many drivers already follow their advice, but if everyone did, we could immediately reduce demand several percentage points. In other words: Obama is right.

In fact, Obama's actual energy plan is much more than a tire gauge. But that's not what's so pernicious about the tire-gauge attacks. ... The real problem with the attacks on his tire-gauge plan is that efforts to improve conservation and efficiency happen to be the best approaches to dealing with the energy crisis — the cheapest, cleanest, quickest and easiest ways to ease our addiction to oil, reduce our pain at the pump and address global warming. It's a pretty simple concept: if our use of fossil fuels is increasing our reliance on Middle Eastern dictators while destroying the planet, maybe we ought to use less.

The RNC is trying to make the tire gauge a symbol of unseriousness, as if only the fatuous believed we could reduce our dependence on foreign oil without doing the bidding of Big Oil. But the tire gauge is really a symbol of a very serious piece of good news: we can use significantly less energy without significantly changing our lifestyle. The energy guru Amory Lovins has shown that investment in "nega-watts" — reduced electricity use through efficiency improvements — is much more cost-effective than investment in new megawatts, and the same is clearly true of nega-barrels. ...

Of course, in recent years, the Republican Party has been affiliated with the oil industry. ... John McCain has been a notable exception. He is not an oilman; he has pushed to regulate carbon emissions; and he opposed Bush's pork-stuffed energy bill, which Obama supported. He also opposed efforts to drill in the Arctic National Wildlife Refuge and until recently opposed new offshore drilling. But now that gas prices have spiked, McCain is running for President on a drill-first platform, and polls suggest that most Americans agree with him. It's sad to see his campaign adopting the politics of the tire gauge, promoting the fallacy that Americans are powerless to address their own energy problems. Because the truth is: Yes, we can. We already are.

Windfall Profits Taxes: Still a Bad Idea

by Josh Barro

Yesterday, the Wall Street Journal's editorial page took another much-deserved thwack at Barack Obama's execrable "windfall profits tax" proposal. (Unfortunately, between this idea and John McCain's gas tax holiday plan, we know that stupid energy tax gimmicks are de rigueur for today's presidential candidates.) The WSJ correctly notes that oil companies' profit margins are not outsized, and that companies like Google look a lot more "unreasonably" profitable than Exxon.

High oil prices are a signal of strong demand and scarce supply, and they provide an incentive for increased production. Taxes discourage production because they drive a wedge between the price paid by the consumer and received by the supplier. Windfall profits taxes also drive up oil imports because they discriminate against domestic oil producers to the benefit of the Saudis and the Venezuelans—even Barack Obama lacks the power to impose production taxes on foreign oil producers.

It's almost cliché to invoke Jimmy Carter when discussing Barack Obama, but I'm going to do it anyway, because it's so appropriate here. Back in 1980, then-President Carter signed into law the Crude Oil Windfall Profits Tax Act, which imposed a 70% excise tax on the amount of an oil sale price exceeding $12.81 per barrel ($36.14 in 2007 dollars). The terms of the new windfall tax are undefined, but Obama says the government would take "a reasonable share" of oil company profits—whatever that means—by imposing a tax on oil sold over the arbitrary price of $80 per barrel.

As we discussed a few years ago, Carter's windfall profits tax fell far short of its projected revenues, partly because it discouraged domestic production and partly because worldwide economic events caused oil prices to fall sharply during the early 1980s. According to the Congressional Research Service, the Carter-era windfall profits tax:

• Reduced domestic oil production by 3-6%; and
• Increased foreign oil imports by 8-16%.

If foreign producers have the capacity to offset all the lost domestic production, then the windfall profits tax will simply shift domestic consumption from domestic to foreign oil with no effect on pump prices at all. On the other hand, if foreign producers can't turn up the taps to offset reduced U.S. production—Saudi Arabia in particular may not be able to meet its ambitious production targets—then not only will we be more dependent on foreign oil, but pump prices will rise to bring demand in line with newly-reduced supply.

So there's your windfall profits tax in a nutshell: reduced domestic production, increased dependence on foreign oil, and pump prices either unchanged (best case) or higher (worst case).

SCHOOL CHOICE

Housing bill

A hair of the dog

Congress has been too lenient on Fannie Mae and Freddie Mac

IT IS hard to deal with an alcoholic. But most experts would agree that the answer is not to leave your credit card behind the bar, persuade the pub landlord to stay open till dawn and leave the inebriate to get on with it. Sadly that is how the American Congress, in its new housing bill, is treating those troubled mortgage groups, Fannie Mae and Freddie Mac.

A rescue of the pair was inevitable. With some $5.2 trillion of debt owned or guaranteed by the duo, their collapse could have ushered in financial catastrophe. Nor could the government close Fannie and Freddie to new business and wind down their old operations. Without them, the mortgage market in America would shut.

But imagine that Fannie and Freddie had turned for financial support to Hank Paulson not as treasury secretary but in his old incarnation as head of Goldman Sachs. Goldman would have insisted that the companies paid a high price: shareholders would probably have been wiped out. Just look at the deal that Lone Star, a private-equity firm, has struck with Merrill Lynch to buy the latter’s dodgy mortgage-related assets: not only is Lone Star paying a mere 22 cents on the dollar, Merrill is lending it most of the purchase money. By comparison, the federal government’s negotiating skills look more like those of Donald Duck than of Donald Trump.

The housing bill imposes no changes in management or approach on Fannie and Freddie and no penalties on shareholders. The American taxpayer is instead given two flimsy protections. The first is that the treasury secretary will have the right to dictate terms if the government does have to stump up equity capital. In the past Mr Paulson could generally be trusted to do the right thing, but he will be gone in six months.

The second protection is the creation of a new regulator. But the existing regulator has been hamstrung by Congress, thanks to the immense lobbying clout of Fannie and Freddie. Shamefully, a proposal to eliminate their lobbying budgets was not even put to a vote on the Senate floor. Government departments are not allowed to lobby Congress; why are these two firms, whose debts now have an explicit government guarantee, permitted to do so?

Heads they win

If Fannie and Freddie are too important to be allowed to collapse, and the American government is really responsible for their debts, then they should be nationalised. The current arrangement allows managers and shareholders to take all the profits and leave the losses to the taxpayer.

If they were nationalised, Fannie and Freddie could be returned to the private sector when the housing market recovers. Privatisation should then create a much wider range of competing entities. It is not entirely clear why the core business of the enterprises—providing guarantees for mainstream (not subprime) mortgages—needs government sponsorship.

The bill does have some prudent parts. The plan to alleviate home foreclosures via a government guarantee both penalises the lenders (they must accept a loss of 10-20%) and gives the government a share of the upside if prices recover. But these provisions are voluntary and it seems unlikely that many lenders will go for them; an earlier scheme, requiring a write-down of only 3% for the banks, had few takers.

The whole package is an attempt to throw government cash at a market that is already heavily distorted by tax breaks and subsidies. And it comes at a time when house sales, if not prices, look at last to be bottoming. Nationalisation, followed by speedy, full privatisation would have been so much better. Are there are any free-market capitalists left in Congress?